Thursday, January 8, 2009

Auditors - a follow up...

This is strange – but anyone that thinks that markets necessarily get the right outcome is just plain wrong.

There is consensus amongst my readers that the big 4 accounting firms have little to recommend them. They are bureaucratic, expensive, not particularly responsive to small customers and not particularly competent. Frauds get through them rather frequently so they should not even give comfort.

There is a strong view (not a majority – but too strong to be ignored) that they are better for marketing purposes, and a view held by some that using a big 4 firm lowers my litigation risk.

The case for using a big 4 firm comes down to the view that they are well known and appealing to clients but my competent one-state audit firm is not well known and is hence unappealing...

Now if Bronte Capital made its investment decisions this way we would soon be out of business. Don’t worry about buying the best investment we can – buy the one that looks best to clients!

But seriously the big 4 firms have a lot to answer for. Three of them audited Madoff feeder funds and PWC has Satyam to add to its (long) list of distinctions. They have between them audited all the big financials that got us into this mess – and yet – strangely – the mess that the audit world is in now is making the marketing value of a big 4 name even stronger.

This is really peculiar. The firms that led us into this mess are the beneficiaries (at least at the moment) of the mess that they created. This is the accounting firm equivalent of a CEO who blew up a company getting a $50 million severance.

It stinks.

Next we are going to hear how important rating agencies are now that debt is defaulting. Moody’s stock will go to infinity!

We are going to discuss this with our foundation clients – but the likely outcome is that we will chose the best firm rather than the name firm. Treat this as “just another investment decision”. [The foundation clients have a big say – and if they wish to go the other-way that is reluctantly what we will do.]

I used to be a partner at a small HF, London-based. And I really like your blog. We faced the same issue - which auditor to use. We went w/ a big 4 firm. Just to get around the issue w/ potential clients of "who's THAT?" and "why didn't you use a REAL firm?" You get 30 min to pitch your fund - you don't spend ANY of it on who's your auditor. You're correct that a smaller firm WILL do a better audit, but marketing the fund is more important than a better audit. If you want to move into the mainstream of funds, go w/ the big 4. Your foundation investors may not WANT you to go more mainstream & they may want a better audit, but think about YOUR business first.

I have no doubt that your commenters are right that hiring a big four company is something of a marketing ploy. It conveys that your books are legit. Anyhow, that is how it would seem to work in the very near term. But the big four have been mucking up tremendously over the years, and as you have pointed out they aren't terribly competent and are terribly expensive. Others must be making this observation as well. At some point in the near future, I would think a sizable number of people would come to that realization as well. Certainly the Madoff deal will expedite the process.

To xtra I say, no people will not come to the realization of anything. Questioning the norm requires soul courage and most are not designed for that.

As for Audit firms not being designed to detect fraud, my question is...WHY NOT? Sounds like they're not cheap anyways. By the way, there is something called Forensic Accounting and when you're auditing billions of dollars at stake why cut corners? Why can fraud detection not be an essential part of any audit for a firm the size of Satyam.

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